prof. joseph e. stiglitz columbia university march 3, 2005 the global economy: the puzzles of 2004,...
TRANSCRIPT
Prof. Joseph E. StiglitzColumbia University
March 3, 2005
THE GLOBAL ECONOMY: THE PUZZLES OF 2004, THE
PROSPECTS OF 2005
Paris, France
The Two Puzzles
2004 was, on the face of it, one of the most best years for growth in the global economy; yet there was not a feeling of global prosperity (at least comparable to the 1990’s)
In spite of huge US borrowing, and prospects of even increased borrowing in future, long term interest rates remain very low
Why?
The Short Answer Strongest boom in Asia, not in Europe and the U.S.
America’s growth numbers good, but employment numbers disappointing- Huge levels of disguised unemployment and
underemployment- Growth not sustainable:
Some from temporary tax provisions, shifting investment from 2005 to 2004
Huge debt overhang in household sectorHuge fiscal deficit - Cutbacks in long term
investmentsHuge trade deficit
Europe continues to languish
Debates about the root causes– Lack of aggregate demand
Poor institutional framework— Stability Pact and independent central bank focusing only on inflation
– Labor market rigidities– Probably both are relevant, but Europe did not
suddenly become more rigid Without better macro-framework, there can be
little robust growth
The Short Answer
High Level of Global Uncertainty
Volatile Exchange rates:- Not a zero sum game- All lose with uncertainty
Volatile Oil prices:- Worst of possible worlds- High oil prices - but not sure that they will be sustained—so little
investment- U.S. foreign policy may be responsible for spreading instability
Global Growth Outlook for 2005OECD
Economic Outlook1
IMF World Economic Outlook
EIUCountry Reports3
2004 2005 2004 2005 2004 2005
U.S. 4.4 3.3 4.3 3.5 4.4 3.1
Euro Area 4 1.8 1.9 2.2 2.2 2.4 2.1
Japan 4.0 2.1 4.4 2.3 2.8 1.3
China 9.0 7.5 9.0 8.0
OECD 3.6 2.9 3.6 2.9 3.4 2.5
World - - 5.0 4.3 5.0 4.1
1. OECD Economic Outlook 76, http://www.oecd.org/dataoecd/21/13/33975094.pdf2. IMF World Economic Outlook http://www.imf.org/external/pubs/ft/weo/2004/02/pdf/chapter1.pdf3. EIU Country Report: USA http://db.eiu.com/report_dl.asp?mode=pdf&eiu_issue_id=15179517514. The EIU Forecast for Euro Area is actually for EU25
Growth prospects for 2005 is lower than it was in 2004, for all economic groups and regions, including China!
Whither the dollar?
Another Puzzle: Why was the huge U.S. fiscal and trade deficit of the early 80s
accompanied by a strong exchange rate, but today’s fiscal and trade deficit by a weak exchange rate?
- As a percentage of GDP, trade deficit is larger -- increased from -1.46% in 1983 to - 5.39% in 2004 (WDI and EIU)
- As a percentage of GDP, fiscal deficit is lower, from -5.47% in 1983 to -3.7% in 2003 (BEA)
Basic Economics: Trade deficit = capital inflows Capital inflows = domestic investment – domestic
savings
Effects of Fiscal Deficit
Large fiscal deficit contributes to low domestic savings:
Net National savings (as % of GNI) rate has fallen from 5.8% in 2000 to about 1% in 2004 (BEA)
National savings rate today is even lower than it was during the bad years of early 80s – it was 4.7% in 1983
Capital inflows (and therefore trade deficit) would be larger, except that domestic investment is weak– Gross domestic investment fell from 18.5 % of GNI
in 2000 to under 13% in 2004
PrognosisContinuing large fiscal deficits:
If the U.S. economy had a strong recovery, investment would increase and trade deficit would get worse
But prospects for investment in 2005 are weak – end of tax break for investment spending (due to end in 2005), and rising interest rates will reduce capital expenditure
Administration is asking to make tax cuts permanent And partial privatization of social security Both would add trillions to deficit - Making the 2001, 2002, and 2003 tax cuts permanent
will increase fiscal deficits by $2.0 trillion through 2014 ; Social security privatization may add another $1.5 trillion to the deficit in first 10 years, $5 trillion in the next 10 years
Key Question What exchange rate will accommodate these capital
flows/trade imbalances?
Real factors: U.S. imports are likely to remain robust
– Growth somewhat moderated– But little change in import share of GDP– Uncertainty about oil prices
U.S. exports will be limited by slow global economic growth– Growth to be lower in 2005 than in 2004
• European Stability Pact’s focus on inflation and other problems will limit European growth
Financial Factors:
Would revaluation of Yuan matter?
Not much for U.S. trade deficit (for arguments already made)
Trade deficit would appear somewhere else Europe might be helped Low price elasticity of demand for Chinese goods? Some of price adjustment would occur in China and
in margins So, even effect on other countries would be limited
Key Question
Key QuestionFinancial Factors:
Would revaluation of Yuan be in the best interest of China?
Large balance sheet effects– Just as a devaluation is bad for country with large dollar
denominated debts, appreciation is bad for country with large dollar denominated assets
– Magnitude of capital loss is huge Would dampen inflationary pressures
– But how serious a problem is inflation today? Might dampen global political pressures on China
– But if trade imbalance, loss of jobs in manufacturing remain large, only temporary palliative
If there is significant price elasticity, there may be better ways to do this
On the real side, prospect of a stronger dollar remains slim! Both real and financial considerations contribute to a cloudy outlook for the global economy and for dollar
The Basic Problems Deteriorating confidence in the U.S. economy and the U.S.
leadership, mainly due to worsening fiscal deficit- Short run problem is the tip of iceberg- U.S. uses ten year budget projections, but Changes in U.S. fiscal position as a result of Medicare bill alone in the next twenty years are in the range of $2.5-3.0 trillion - There simply isn’t room in discretionary budget to make the arithmetic work
And some of the cutbacks will be in areas which will harm U.S. long term economic growth– Investments in science and technology– Already suffering from war on terrorism, as supply of
foreign engineers/scientists/students drying up– And suffering from anti-science stance of administration,
or at least widespread perception of that within the scientific community
End of Dollar as the Reserve Currency Reserve currencies need to be good store of value Which is why inflation has always been viewed so
negatively by central bankers But the credibility of a currency as a reserve currency
depends also on exchange rates For foreign holders of dollars, weakening of the
exchange rate is as bad as an increase in inflation Even true for domestic wealth holders, because of
opportunity costs Negative dynamics—as confidence erodes, people
move out of currency, weakens currency Problem is partly inherent—reserve currency country
gets increasingly in debt as others hold its currency; ease of selling debt entices borrowing; but eventually, debt gets so large that credibility is questioned
Now there are alternatives to dollar And many in Asia are waking up to the new realities
– They are the world’s net savers– Why should they be lending money to the richest country of
the world at low interest rates?– Basic principles of portfolio diversification would call for
diversification of reserve assets– And increased perceived risk associated with U.S. dollar would
lead to further diversification out of the dollar– For small countries, this is easy– But for large countries, more difficult
Political ramifications Balance sheet effects as they move out Argues for a policy of gradualism And for the anticipation of further weakening of dollar
With so much of U.S. debt held as reserves, politics, not just economics, become important in determining exchange rates and even possibly long term Treasury interest rates
End of Dollar as the Reserve Currency?
Alternative Scenarios
Best case (for strong U.S. dollar): U.S. reins in its fiscal deficit Europe successfully pursues more expansionary policy Asian countries decide to continue to gamble on
holding dollar as reserve currency, no progress on Asian cooperative front
More pessimistic case: U.S. deficit not brought under control, and actually
increases with partial privatization of social security and permanent tax cut
Proposed budget gimmickry in social security unlikely to fool anyone
More Pessimistic Case: Financial markets wake up to long run prospects of U.S.
fiscal position and its long run real consequence– Political gridlock in the U.S.– Impossible to raise taxes, impossible to cut back
significantly on commitments– Especially problematic given huge gap between US’s
health technology and its health performance– Social tensions rise as even those in the middle see their
incomes erode (real median family income in U.S. down by $1,500)
Markets and governments wake up to changing global economic scene– Strength in science and engineering in China and India– Scientists are mobile; U.S.’s dominance partly due to
migration after World War II
Alternative Scenarios
More Pessimistic Case:
Political and economic pressures build up for movement out of dollar as reserve currency– Political accountability for foreseen loses in value of reserves– Popular sentiment about lending to U.S. at low interest rates,
demands for Asian cooperation, sensibilities about how to do it quietly
– WTO limits retaliation by U.S., though there will be plenty of talk
• Eventually U.S. and global real long term interests rise (matter of supply and demand), risk premiums rise, with adverse effects on weaker emerging economies, possibly new crises, and on U.S. economy, with heavy debt overhang
Alternative Scenarios
Concluding Remarks
Economics and politics are intimately intertwined
Economic forecasting is difficult Political forecasting is even more difficult The most sure bet is continued high levels
of uncertainty And even that is uncertain